CHAPTER-2

Goodwill: Nature and Valuation

Units/Topics Learning Outcome
Goodwill: meaning, nature, factors After going through this Unit, the
affecting and methods of valuation - students will be able to:
average profit, super profit and state the meaning, nature and factors
capitalization. affecting goodwill.
Note: develop the understanding and skill of
valuation of goodwill using different
methods.
Meaning of Goodwill:- It is the reputation that helps the business to earn more profits as compared to
a newly setup business. In accounting, the monetary value of such advantage is known as “goodwill”.
Factors Affecting the Value of Goodwill:-
The main factors affecting the value of goodwill are as follows:
(a) Nature of business (b) Location (c) Efficiency of management. (d) Market situation.
Need for Valuation of Goodwill
In a partnership firm, goodwill needs to be valued in the following circumstances:
1. Change in the profit sharing ratio amongst the existing partners;
2. Admission of new partner;
3. Amalgamation of partnership firm.
4. Death of a partner and
5. Dissolution of a firm involving sale of business as a going concern. 6. Retirement of a partner;
Methods of Valuation of Goodwill:-
1.Average Profits Method:-
(A) Simple Average:- Stepwise procedure to calculate Goodwill under this method:
Step 1: Work out profits or losses given for each of the past year after taking into account abnormalities, if
any.
Step 2: Average Profit = Total Profits / no. of years
Step 3: Goodwill= Average Profit x Number of year's purchase.
Note :- If in any questions some items are omitted to be recorded in this condition actual profit
will be calculated.
Statement of Calculation of Actual Profit/Loss
Particulars Amount (Rs.)
Profit/Loss xxxxxx
(+) Abnormal Losses (e.a. Loss by fire, Loss on theft etc.) xxxxxx
(+) Non Operating Expenses (e.a.- Loss on sale of Fixed Assets) xxxxxx
(+) Over valuation of Opening Stock xxxxxx
(+) Under Valuation of Closing Stock xxxxxx
(-) Abnormal Gain xxxxxx
(-) Non- Operating Income xxxxxx
(e.a.-Profit on sale of Fixed Assets, Dividend Received,Interest Received,
Rent Received)
(-) Under valuation of Opening Stock xxxxxx
(-) Over Valuation of Closing Stock xxxxxx

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 (-) Partner’s Salary/Remunaration. xxxxxx
Actual Profit /Loss xxxxxx
(b) Weighted Average Profit:-
Calculation of Weighted Profit
Years Profit Weights Weighted Profits (Column-4)
(Column-1) (Column-2) (Column -3) Column 2 X Column 3)
Weighted Average Profit = Total Weighted Profit / Total Weights
Goodwill = Weighted Average Profit x No of Purchase Years.
(2) Super Profit Method:- Stepwise procedure to calculate Goodwill under this method:
Step-1 Calculate the average profit,
Step-2 Calculate the normal profit on the capital employed on the basis of the normal rate of return,
Formula , Normal Profit = Capital Employed x Normal Rate of Return /100
Step-3 Calculate the super profits by deducting normal profit from the average profits, Formula,
SuperProfit = Average Profit - Normal Profit
Step-4 Goodwill = Super profits x Number of years 'purchase.
Note:- If in question Capital Employed is not given so
Cpaital Eployed= Total Assets- Outside Liabilities
(OR)
Capital Employed = Total Capital of the all Partners + Reserves + Profit/loss
(3) Capitalisation Method:- Under this method the goodwill can be calculated in two ways:
(a) by Capitalizing the Average Profits, or
(b) by Capitalizing the Super Profits.
(a)Capitalisation of Average Profits:
capitalised value of Average Profits = Average Profits x 100/Normal Rate of Return
Goodwill = Cpaitalised Value of Average Profit – Capital Employed
(b) Capitalisation of Super Profits: It involves the following steps
Goodwill = Super Profits x 100/ Normal Rate of Return
Practice questions
Average profit Method
Q.1 Compute the value of goodwill on the basis of four years' purchase of the average profits
based on the last five years? The profits/losses for the last five years were as follows: 2017 –
₹ 25,000; 2018 – ₹ 40,000; 2019 - (₹ 15,000) loss; 2020 – ₹ 80,000; 2021 – ₹ 1,00,000
Q.2 According to partnership deed, goodwill of a firm is valued at two years’ purchase of the
average profit of the last 3 years’. The profits of the last 3 years were as follows Rs.50,000,
Rs. 45,000, Rs. 61,000. Calculate the value of goodwill of the firm.
Q.3 Goodwill of a firm is valued at 21/2 years, purchase of the average profits of the last 5 years.
The profits of the last five years were Rs.18,000, Rs.24,000, Rs.9,000 (Loss),Rs.27,000,and
Rs.40,000. Compute value of the Goodwill of the firm.

Q.4 Followings are the profits of the firm for the last 3 years:
2022- Rs.40,000 including profits on sale of a land Rs.5,000.
2023- Rs.50,000 including Rs.10,000 loss on sale of Machinery.
2024- Rs.45,000 excluding Rs.5,000 payable for insurance premium.
Compute the value of goodwill of the firm on the basis of two years’ purchase of average
profits of the last three years.

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Q.5 Find the value of the goodwill of a firm on the basis of two years’ purchase of last 4 years
average profits. The profits of the last 4 years were: Rs.30,000, Rs.45,000, Rs. 40,000, and
Rs.43,000. The profits of first year includes theft of goods Rs.3, 000, profit of second year
includes abnormal gain of Rs.3,000 while profits of fourth year includes speculative profit of
Rs.2,000.
Weighted Average Profit Method
Q.6 The profits of the firm for last 5 years were as follows:
2010- Rs. 19,000,2011- Rs. 25,000, 2012- Rs.27,000,2013- Rs.30,000, 2014- Rs.33,000.
Calculate goodwill on the basis of 2 years’ purchase of weighted average profits. The
weights were 1,23,4 and 5 respectively.
Q.7 Compute of the firm on the basis of the last 3 years’ purchase of the weighted average
profits of last 4 years. The profits of the last 4 years were:
2021- Rs.25,000,2022-Rs.30,000, 2023- Rs.24,000, and 2024- Rs. 38,000.
The weights were 1, 2, 3, and 4. Following information is supplied to you:
(a) In 2023 a major repair was made in plant and Machinery to Rs.10,000 on 1 st July
which was charged to revenue account. The said sum is agreed to be capitalised for
goodwill computation subject to depreciation @10% p.a. on reducing balance
method.
(b) The closing stock of 2012 was overvalued by Rs.3,000.
The Accounts are closed on 31st December each year.
Q.8 Find the goodwill of affirm on the basis of two years’ purchase of the weighted average
profit of the last 4 years. The profits of the last 4 years were:
(a) 2021- Rs.20,000, 2022-Rs. 30,000, 2023- Rs. 25,000 ,2024-Rs.38,000 The weights
assigned were 1,2,3,and 4 respectively.
On scrutiny it was found that:
(a) On 1st January 2023 heavy repairs made on plant and Machinery amounting to
Rs.8,000 was charged to revenue account. The said sum is agreed to be capitalised
for goodwill computation. This is subject to 10% depreciation on straight line
method.
(b) The closing stock of 2022 and 2024 were overvalued by Rs.1,000 and 2,000
respectively.
(c) To cover the management cost an annual charge of Rs.3,000 should be made for
goodwill valuation.
The Accounts are closed on 31st December each year
Q.9 Find the goodwill of affirm on the basis of two years’ purchase of the weighted average
profit of the last 4 years. The profits of the last 4 years were:
(a) 2021- Rs.20,000, 2022-Rs. 30,000, 2023- Rs. 25,000 ,2024-Rs.38,000 The weights
assigned were 1,2,3,and 4 respectively.
On scrutiny it was found that:
(d) On 1st January 2023 heavy repairs made on plant and Machinery amounting to
Rs.8,000 was charged to revenue account. The said sum is agreed to be capitalised
for goodwill computation. This is subject to 10% depreciation on straight line
method.
(e) The closing stock of 2022 and 2024 were overvalued by Rs.1,000 and 2,000
respectively.
(f) To cover the management cost an annual charge of Rs.3,000 should be made for
goodwill valuation.

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 The Accounts are closed on 31st March each year
Super Profit
Q.10 A partnership firm has earn net profit during the last 3 years as 2021-Rs.18,000, 2022- Rs.
22,000 and 2023- Rs. 26,000.The firm has a fixed capital of Rs.1,00,000 and 15% is
considered as fair return on capital employed.
Calculate the value of the goodwill on the basis of 3 years’ purchase of super profit.
Q.11 A firm expect to earn Rs.36,000 per year after employing Rs.2,00,000 as capital. The rate of
earning in the industry is 12%. The remuneration payable to partners is Rs. 5000 p.a.
Compute the goodwill of the firm on the basis of 4 years, purchase of super profit.
Q.12 A business earned average profit of Rs.3,00,000 during the last few years. The normal rate
of return in the similar business is 10%.The total value of the assets and liabilities of the
business were Rs.22,00,000 and Rs.5,60,000 respectively. Calculate the value of the goodwill
of the firm by super profit method, if the goodwill is valued 2.5 years, purchase of super
profit
Q.13 The average profits of the firm earned Rs.60,000 including abnormal gain of Rs.4,000 on
recurring basis. Firm had a fixed assets of Rs.3,00,000 and Current assets of Rs.60,000 and
creditors Rs.1,40,000.Calculate goodwill of the firm based on 3 times of the super profits if
the normal rate of return is 10%.
Capitalisation Method
(a) by Capitalizing the Average Profits
Q.14 A firm has earned average profits of the Rs.1,00,000 during the last few years and the
normal rate in similar business is 10%. Find the value of goodwill by :
Capitalisation of average profit.
The firm has assets of Rs.10,00,000 and external liabilities Rs.1,80,000.
Q.15 A firm has earned average profits of the Rs.1,00,000 during the last few years and the
normal rate in similar business is 10%. Find the value of goodwill by :
Capitalisation of Super profit.
The firm has assets of Rs.10,00,000 and external liabilities Rs.1,80,000.
MCQS-MULTIPLE CHOICE QUESTION:-
Q.1 Super profit can be calculated:-
(a) Average profit-Normal profit (b) Net profit – Average profit
(c) Capital Employed –Net Profit (d) Net Profit – Capital Employed
Q.2. Which step is not involved in valuing the goodwill according to Super Profit Method:
(a) Ascertain Average profit (b) Multiply Super Profit with Number of years purchased
(c) Ascertain Normal Profit (d) Ascertain Super Profit
Q.3 If Average Profit =₹ 1, 60,000, Actual Capital Employed = ₹ 5,00,000. If rate of Normal Profit = 20%.
What is the amount of Super Profit?
( a) ₹ 60,000 (b) ₹ 1,00,000
(c) ₹ 20,000 (d) ₹ 80,000
Q.4 If Goodwill is ₹ 1,20,000, Average Profit is ₹ 60,000 Normal. Rate of Return is10% on Capital
Employed ₹ 4,80,000. Calculate Capitalized Value of the firm:-
(a) ₹ 6,00,000 (b) ₹ 5,00,000
(c) ₹ 4,00,000 (d) ₹ 7,00,000
Q.5 Tangible Assets of the firm are ₹ 14,00,000 and Outside liabilities are ₹ 4,00,000, Profit of the firm is
₹ 1,50,000 and Normal Rate of Return is 10% Calculate Capital Employed
(a) ₹ 10,00,000 (b) ₹ 1,00,000
(c) ₹ 50,000 (d) ₹ 20,000

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Q.6 A business has earned Super profit of ₹ 1,00,000during the last few years and Normal rate of returns
in 10% Calculate goodwill
(a) ₹10,00,000 (b) ₹ 54,000
(c) ₹ 20,000 (d) ₹ 36,000
Q.7 Goodwill of the firm on the basis of 2 years' purchase of average profit of the last 3 years is ₹ 25,000.
Find average profit.
(a) ₹ 50,000 (b) ₹ 25,000
(c) ₹ 10,000 (d) ₹ 37,500
Q.8 Calculate the value of goodwill at 3 years' purchase of Super Profit, when: Capital employed ₹
2,50,000; Average profit ₹ 30,000 and normal rate of return is 10%.
(a) ₹ 3000 (b) ₹ 25,000
(c) ₹ 30,000 (d) ₹1 5,000
Q.9 What are super profits:-
(a) Actual profit – Normal Profit (b) Normal Profit - Actual profit
(c) Actual profit + Normal Profit (d) None of the above
Q.10 The net assets of the firm including fictitious assets of ₹ 5,000 are ₹ 85,000. The net liabilities of the
firm are ₹ 30,000.The normal rate of return is 10% & the average profits of the firm are ₹ 8,000.
Calculate the goodwill as per capitalization of super profits
(a) ₹ 20,000 (b) ₹ 30,000
(c) ₹ 25,000 (d) None of the above
Q.11 Which of the following items are added to previous year’s profits for finding normal profits for
valuation of goodwill?
(a) Loss on sale of fixed assets (b) Loss due to fire, earthquake etc
(c) Undervaluation of closing stock (d) All of the above
Q.12 The profits earned by a business over the last 5 years are as follows ₹ 12,000; ₹ 13,000; ₹ 14,000: ₹
18,000 and ₹ 2,000 (loss). Based on 2 years purchase of the last 5 years profits, value of Goodwill will
be :
(a) ₹ 23,600 (b) ₹ 22,000
(c) ₹ 1,10,000 (d) ₹ 1,18,000
Q.13 Following are the methods of calculating goodwill except:
(a) Super Profit method (b) Average Profit method
(c) Weighted Average Profit method (d) Capital Profit method
TRUE / FALSE :
Q.1 Location of business does not affect the goodwill of business.
Q.2 “Average profit method” takes into consideration the future maintainable profits.
Q.3 Goodwill can be sold in part.
Q.4 Purchased goodwill may arise on acquisition of an existing business concern.
Q.5 Self-Generated goodwill is recorded in the books of accounts as some consideration is paid for it.
Q.6 Goodwill is a fictitious asset.
Q.7 Goodwill is valued during dissolution of a firm.
Q.8 In the event of change in profit sharing ratio, General Reserve existing in the Balance Sheet is
transferred to capital accounts of partners in their new ratio.
ANSWERS KEY
Ans. 1 Average Profit = Total Profits / Loss / No of Years
Average Profit = 25000 (+) 40,000 (-) 15,000 (+) 80,000 (+) 1,00,000 / 5
Average Profit = 2,30,000 / 5
Average Profit = 46,000
Goodwill = Average Profit x No of Purchase Years

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 Goodwill = 46,000 x 4 = Rs. 1,84,000
Ans.2 Goodwill of the firm Rs.1, 04,000
Ans.3 Goodwill Rs.50, 000 of the firm.
Ans.4 Ans.3 Goodwill Rs.90,000 of the firm.
Calculation of Actual Profit
Particulars 2022 (Rs.) 2023 (Rs.) 2024 (Rs.)
Profit/Loss 40,000 50,000 45,000
(-) Profit on Sale of Land (5,000)
(+) Loss on Sale of Machinery 10,000
(-) Insurance Premium (5,000)
Actual Profit 35,000 60,000 40,000

Average Profit = Total Actual Profits / No of Years = 35,000 (+) 60,000 (+) 40,000 / 3
Average Profit = 1,35,000/3 = 45,000
Goodwill = Average Profit x No of Purchase Years
Goodwill = 45,000 x 2 = Rs. 90,000
Ans.5. Goodwill Rs.78,000 of the firm.
Ans.6 Calculation of Weighted Profit
Years Profit Weights Weighted Profits (Column-4)
(Column-1) (Column-2) (Column -3) Column 2 X Column 3)
I 19,000 1 19,000 X 1 = 19,000
II 25,000 2 25,000 X 2 = 50,000
III 27,000 3 27,000 X 3 = 81,000
IV 30,000 4 30,000 X 4 = 1,20,000
V 33,000 5 33,000 X 5 = 1,65,00
15 4,35,000

Weighted Average Profit = Total Weighted Profit / Total Weights

Weighted Average Profit = 4,35,000 / 15 = Rs.29,000
Goodwill = Weighted Average Profit x No of Purchase Years.
Goodwill = 29,000 x 2 = Rs.58,000
Goodwill Rs.58,000 of the firm.
Ans.7 Calculation of Actual Profit
Particulars 2021 2022 (Rs.) 2023 (Rs.) 2024 (Rs.)
(Rs.)
Profit/Loss 25,000 30,000 24,000 38,000
(+) Major Repairs of Machinery 10,000
(Capital Expenditure)
(-) Depreciation on Machinery (500) (950)
(-) Overvaluation of Closing Stock (3,000)
(+) Over Valuation of Opening Stock 3,000
Actual Profit 25,000 27,000 36,500 37,050

Working Note-
(1) Calculation of Depreciation on Machinery From 1st July 2022 to 31st December 2023 =
10,000 x 10/100 x 6/12 =Rs.500
In the year 2024 – Reducing balance Method 10,000 (-) 500 = 9,500 x 10/100 = 950

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 Goodwill Rs.1,01,010 of the firm.
(2) Overvaluation of Closing Stock in the 2022 is treated Opening Stock in the year 2023.
Calculation of Weighted Profit
Years Profit Weights Weighted Profits (Column-4)
(Column-1) (Column-2) (Column -3) Column 2 X Column 3)
2021 25,000 1 25,000 X 1 = 25,000
2022 27,000 2 27,000 X 2 = 54,000
2023 36,500 3 36,500 X 3 = 1,09,500
2024 37,050 4 37,050 X 4 = 1,48,200
10 3,36,700

Weighted Average Profit = Total Weighted Profit / Total Weights

Weighted Average Profit = 3,36,700 / 10 = Rs.33,670
Goodwill = Weighted Average Profit x No of Purchase Years.
Goodwill = 33,670 x 3 = Rs.1,01,010
Ans.8 Calculation of Actual Profit
Particulars 2021 2022 (Rs.) 2023 (Rs.) 2024 (Rs.)
(Rs.)
Profit/Loss 20,000 30,000 25,000 38,000
(+) Major Repairs of Machinery 8,000
(Capital Expenditure)
(-) Depreciation on Machinery (800) (800)
(-) Overvaluation of Closing Stock (1,000) (2,000)
(+) Over Valuation of Opening Stock 1,000
(-) Management Cost (3,000) (3,000) (3,000) (3,000)
Actual Profit 17,000 26,000 30,200 32,200

Working Note-
(1) Calculation of Depreciation on Machinery From 1st January 2023 to 31st December 2023 =
8,000 x 10/100 =Rs.800
In the year 2024 –Rs. 800 due to Straight line Method
(2) Overvaluation of Closing Stock in the 2022 is treated Opening Stock in the year 2023.
Calculation of Weighted Profit
Years Profit Weights Weighted Profits (Column-4)
(Column-1) (Column-2) (Column -3) Column 2 X Column 3)
2021 17,000 1 17,000 X 1 = 17,000
2022 26,000 2 26,000 X 2 = 52,000
2023 30,200 3 30,200 X 3 = 90,600
2024 32,200 4 32,200 X 4 = 1,28,800
10 2,88,400

Weighted Average Profit = Total Weighted Profit / Total Weights

Weighted Average Profit = 2,88,400 / 10 = Rs.28840
Goodwill = Weighted Average Profit x No of Purchase Years.
Goodwill = 28840 x 2= Rs.57,680
Ans.9 Calculation of Actual Profit
Particulars 2021 2022 (Rs.) 2023 (Rs.) 2024 (Rs.)

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 (Rs.)
Profit/Loss 20,000 30,000 25,000 38,000
(+) Major Repairs of Machinery 8,000
(Capital Expenditure)
(-) Depreciation on Machinery (200) (800)
(-) Overvaluation of Closing Stock (1,000) (2,000)
(+) Over Valuation of Opening Stock 1,000
(-) Management Cost (3,000) (3,000) (3,000) (3,000)
Actual Profit 17,000 26,000 30,800 32,200

Working Note-
(1) Calculation of Depreciation on Machinery From 1st January 2023 to 31st March2023 =
8,000 x 10/100 x 3/12 =Rs.200
In the year 2024 –Rs. 800 due to Straight line Method for full year
(2) Overvaluation of Closing Stock in the 2022 is treated Opening Stock in the year 2023.
Calculation of Weighted Profit
Years Profit Weights Weighted Profits (Column-4)
(Column-1) (Column-2) (Column -3) Column 2 X Column 3)
2021 17,000 1 17,000 X 1 = 17,000
2022 26,000 2 26,000 X 2 = 52,000
2023 30,800 3 30,800 X 3 = 92,400
2024 32,200 4 32,200 X 4 = 1,28,800
10 2,90,200

Weighted Average Profit = Total Weighted Profit / Total Weights

Weighted Average Profit = 2,90,200 / 10 = Rs.29020
Goodwill = Weighted Average Profit x No of Purchase Years.
Goodwill = 29020 x 2= Rs.58,040
Ans.10 Average Profit = Total Profit / No. of Years
Average Profit = 18,000 (+) 22,000 (+) 26,000 /3 = 66,000/3
Average Profit = Rs. 22,000
Normal Profit = Capital Employed x Normal Rate of Return / 100
Normal Profit = 1,00,000 x 15/100 = 15,000
Super Profit = Average Profit (-) Normal Profit
Super Profit = 22,000 -15,000
Super Profit = Rs.7,000
Goodwill = Super Profit x No of Purchase Years
Goodwill = 7,000 x 3 = Rs. 21,000
Value of the goodwill Rs.21,000.
Ans.11 Goodwill of the firm Rs.28,000.
Ans.12 Capital Employed = Total assets (-) Outside Liabilities
Capital Employed = 22,00,000 (-) 5,60,000
Capital Employed = Rs. 16,40,000
Normal Profit = Capital Employed x Normal Rate of Return / 100
Normal Profit = 16,40,000 x 10/100 = 1,64,000
Super Profit = Average Profit (-) Normal Profit
Super Profit = 3,00,000 (-) 1,64,000

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 Super Profit = Rs.1,36,000
Goodwill = Super Profit x No of Purchase Years
Goodwill = 1,36,000 x 2.5 = Rs. 3,40,000
Goodwill Rs.3,40,000.
Ans.13 Goodwill Rs.69,000.
Ans.14 Capital employed = Total assets (-) Outside Liabilities
Capital Employed (Net Assets) = 10,00,000 (-) 1,80,000 = 8,20,000
capitalised value of Average Profits = Average Profits x 100/Normal Rate of Return
Capitalised Value of Average Profit = 1,00,000 x 100 /10 = 10,00,000
Goodwill = Capitalised Value of Average Profit – Capital Employed
Goodwill = 10,00,000 (-) 8,20,000 = Rs.1,80,000
Godwill of the Firm = Rs,1,80,000
Ans.15 Super Profit= Average Profit (-) Normal Profit
Normal Profit = Capital Employed x Normal Rate of Return /100
Capital employed = Total assets (-) Outside Liabilities
Capital Employed (Net Assets) = 10,00,000 (-) 1,80,000 = 8,20,000
Normal Profit = 8,20,000 x 10/100 = 82,000
Super Profit = 1,00,000 (-) 82,000
Super Profit = 18,000
Goodwill = Super Profit x 100 /Normal rate
Goodwill = 18,000 x 100 / 10 = Rs.1,80,000
MCQS-MULTIPLE CHOICE QUESTION:-
Ans.1 (a)
Ans.2 (a)
Ans.3 (a)
Ans.4 (a)
Ans.5 (a)
Ans.6 (a)
Ans.7 (d)
Ans.8 (d)
Ans.9 (a)
Ans.10 (b)
Ans.11 (a)
Ans.12 (d)
Ans.13 (d)
TRUE / FALSE :
Ans.1 (F)
Ans.2 (T)
Ans.3 (F)
Ans.4 (T)
Ans.5 (F)
Ans.6 (F)
Ans.7 (F)
Ans.8 (F)